The key to a successful portfolio might be in making perfectly informed, calculated decisions. The problem is, investors are human beings, prone to biases.

Nobel laureate Daniel Kahneman understood this better than most. In remembrance of his work, let’s unpack some of the wisdom he’s left behind – and find out how you could use it to become a smarter investor.

System 1: Know your impulses

Kahneman’s exploration of human cognition revealed two modes of thinking that profoundly impact decision-making, which he outlined in his best-selling book, Thinking, Fast and Slow.

The first is System 1, your brain’s fast, automatic gear. It’s your gut reaction, the instinctive decision you make without even realising it. When you’re investing, it can lead you to make hasty, emotion-driven decisions – often to your detriment.

Here are some of those mental biases:

• Anchoring and adjustment: Ever cling to the last price of a stock before it dropped? That’s your brain anchoring – getting stuck on initial impressions or specific levels, and then struggling to adjust.

• Prospect theory: Ever notice how losing $500 stings more than how winning $500 feels good? The brain is wired to fear losses more than it values gains, making humans poor risk assessors, by nature.

• Representativeness heuristic: Spot a young company with rocket-like growth and dub it the next Apple? That’s oversimplifying, mistaking a good story for a sure bet – without checking the fundamentals (our Simply Finance below explains).

System 2: Control your impulses

System 2 is your brain’s slow, analytical device. When you’re considering an investment, it prompts you to dig into the data, consider the market context, and weigh the potential risks and rewards. It requires effort, but it’s your best bet for making informed, rational choices.

Now that you know both systems, the goal is to limit the impact of those stubborn impulses and give your analytical side, System 2, the upper hand.

Here are a few things you can do to make that happen:

• Play devil’s advocate against yourself: Dive into views that clash with yours. Arguing against your own stance can unveil blind spots you never knew you had.

• Have a clear, rule-based, investment process: Spell out your game plan – what you want to achieve, what worries you, where you’re looking for information. The more rules you have, the less room for your biases. That’s why we built our investment framework, ERAA® – it’s a systematic approach that’s built on data, and designed to guide our portfolio allocations. This helps to avoid those pesky biases, minimising risk throughout various economic cycles.

• Make investing as simple as possible: A straightforward, hands-off strategy means fewer chances for biases to butt in – something that we can get behind. An example we wholeheartedly recommend: simply dollar-cost average into any of our General Investing portfolios. With that simple strategy alone, you’d be investing in a mix of assets, diversified globally, and managed automatically for you.

It may take some trial and error, but the more you tune into the way your brain works, the more you’ll understand the behaviour of both yourself and that of other investors – and the more opportunities you’ll find along the way.

This article was written in collaboration with Finimize.

🎓 Simply Finance: Fundamentals

A company’s fundamentals are the facts and figures that can reveal its financial health and future potential. This includes both quantitative metrics, such as revenue and earnings, and qualitative aspects, like industry trends and management effectiveness. Essentially, it’s the financial DNA underpinning a company's performance. Armed with this data, investors can then use fundamental analysis to make decisions – here’s the Simply Finance on that.